The continued rise of retail stock trading

Small investors are playing a larger role in the stock market than at any time this century.

The big picture: Whatever the reason for small investors' rise — lots of free time thanks to the pandemic, zero-dollar commissions, addictive and gamified apps, enticing volatility — retail investors have become a driving force behind many individual stocks and maybe even the market as a whole.

Why it matters: No one can quantify exactly how much retail investors are trading now, compared with pre-crisis. But thanks to SEC Rule 606, which came into force in January, we now have a very good proxy. That proxy shows that the surge in retail investing that started in March isn't slowing down at all. In fact, it's growing.

How it works: Retail brokerages like Robinhood, TD Ameritrade and E-Trade all route their order flow to high-frequency traders like Virtu and Citadel Securities. Those trading firms make so much money buying at the bid and selling at the offer that they're willing to pay millions of dollars for the ability to fulfill the orders. That practice is known as payment for order flow, or PFOF.

• Stocks in the S&P 500 tend to trade with the tightest bid-offer spreads, so their PFOF is relatively small. Other stocks have wider spreads, and command larger PFOF. The biggest PFOF of all comes from options trading.

By the numbers: Frank Chaparro and his colleagues at The Block did the laborious work of finding and aggregating the Rule 606 reports for Robinhood, TD Ameritrade and E-Trade. Those firms between them received $99 million of PFOF in January, pre-crisis. In March, that number spiked to $164 million, and in April it grew even further to $175 million.

• June saw yet another massive jump, registering a stunning $258 million of PFOF just for those 3 firms. Of that amount, $146 million, or 57%, came from options trading.

• Robinhood's take was large, at $139 million for the four crisis months of March through June. But TD Ameritrade's was even bigger, at $226 million. (The numbers for TD Ameritrade and E-Trade do not include figures for Charles Schwab or Morgan Stanley, with whom those companies are set to merge.)

The bottom line: Retail brokerages like to encourage trading so that they can get PFOF. But that PFOF is small (just 8.8% of the total) with respect to individuals trading S&P 500 stocks. The real money is found in options trading.